This research investigates the different characteristics of targets and acquiring firms in the United States defense industry from 1975 through 2000. The goal is to better understand what objectives specific firms were pursuing when they merged, purchased assets or competed with/from other defense companies. In order to use an options methodology approach, we focused on the award of major contracts by the Department of Defense, the competition between Boeing and Airbus, and on two big mergers—Boeing with McDonnell Douglas and Martin Marietta with Lockheed. These two mergers were the largest ever in the aerospace/defense industry.; Many corporate control papers analyze the entire range of non-regulated of firms. The defense industry is not regulated like the financial or utility firms. It is a unique industry that involves manufacturing with very high investment costs, government purchases (both domestic and foreign), and national identity. The investment costs include research and development as well as high asset requirements. What lends this industry to be valued as an option is that the initial investment in projects can be spread out over time and that the assets in place can be switched from civilian to defense and vice versa demanding on the demand from the Department of Defense and industry. Once a contract is won, the true value is not known as the winning firm must further prove the design and it is years before full production contracts are signed. The uncertainty of important variables is high and the ability of management to adapt to this uncertainty is high.; This paper is relevant from both a policy perspective and a financial perspective. It is important with respect to policy due to the importance of the aerospace and defense sector as a percentage of gross domestic product in the United States as well as the continued consolidation in the industry both within the United States and in Europe. The U.S. has not been buying the equipment that will be needed five to ten years from now when the planes and tanks purchased during the Reagan buildup hit the end of their useful life. Western European NATO countries also will need to purchase new military equipment due to the lack of technologically sophisticated weapons systems as evident during the short Kosovo conflict.; Boeing purchased McDonnell Douglas when McDonnell Douglas lost market share in the commercial aviation industry and was focusing on its defense-related business. Martin Marietta's merger with Lockheed followed Lockheed's exit as a prime contractor in commercial aircraft design and production and when their largest new defense product the F-22 was years away from profitable production. The competition of the Joint Strike Fighter between Boeing and Lockheed Martin as well as the competition between Boeing and Airbus for commercial aircraft showed how the two might compete given the uncertain investments and payoffs. The defense and commercial aerospace industry is a particularly interesting industry to apply real options for two reasons: (1) the large costs of developing new projects and (2) the long time frame involved. Looking at each of these projects in a real options context gives new insights into how important the projects are to the various companies.
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